Tax Loss Harvesting - The True Benefits

[TheDudeMan]

For the last 14 years of my investing life I have used a financial planner (and paid the 1% fee).  After much thought and reading, I've decided to go the DIY route through Vanguard. However, after reading a bit more about Betterment, I'm strongly considering them as an option due to TLH. All that said, I'm really struggling to determine the true dollar benefit of tax loss harvesting. Everyone I read and speak with has varying opinions on the true value of the auto TLH of Betterment vs. the long term approach of just buying and holding index funds and waiting to pay capital gains at retirement.  According to my income and current investments, it should be of great use, but I'm reluctant to pay the extra 15 bps for Betterment's services.  Does anybody have a strong opinion that's backed up by data?

For some background, I live in CA, pay approx 45% in taxes on $400k in income, and have $1.4 million in taxable and $400k in tax advantaged accounts.  The question is whether putting my taxable with Betterment and leaving my 401k with Vanguard is the way to go, or am I better off investing it all in Admiral shares with Vanguard and rebalancing every year.

Thanks in advance.

[tonysemail]

The thing I dislike about using the robo service is that you need to hold all of your taxable money there.
Otherwise, they can't avoid wash sale rules on your behalf.
That's what pushes me towards implementing TLH on my own.

what's your cost basis in your taxable account?
If it's low, then isn't it important to NOT liquidate that account?

Here is one method to think it through.
let's presume your shoveling 50% of your gross pay into the market - ~200k/year.
Make up a number of market volatility... I've seen 5-10% this year.
So then recent history says you could have TLH ~20k this year.

[dandarc]

Even if they have all of your taxable money, they can't necessarily avoid wash-sales. 

Sold at loss in taxable, but dividend reinvested because you forgot you had the same fund in your IRA?  Wash-Sale!

Sold at a loss in your account, but your wife's auto-investment happened.  Wash-Sale!

You've got to be damn careful across all your accounts to successfully tax-loss harvest.

[biglawinvestor]

You can certainly do all of the TLH yourself. It's really up to you to decide if 15 bps is worth having someone else perform the service for you. It's good that you've narrowed it down to this issue though, because that's really the difference between going with a robo advisor or Vanguard.

At a $1.4M balance, you're talking about $2,100 in fees a year on 15 bps. That seems pretty steep to me.

@dandarc makes a good point that if you use put the $1.4M in in a robo advisor and keep the $400K retirement accounts at vanguard, you are going to trigger a ton of wash sales. Will the IRS find out? Unlikely, but they will be there all the same.

[TheDudeMan]

let's presume your shoveling 50% of your gross pay into the market - ~200k/year.
Make up a number of market volatility... I've seen 5-10% this year.
So then recent history says you could have TLH ~20k this year.

My guess is that I'm putting away approx $100k/yr.  Going off of your example, if I'm harvesting $10k this year, that seems to make the difference in the $2,100/yr in costs.  I guess the bigger question is whether or not I'm able to track the potential wash sales.

As far as the cost basis, it's surprisingly high.  One of the main reasons for beginning this deep dive into my returns was that they were negligible over the last decade.

If it's determined that there is an advantage to TLH that outweighs the 15 bps/yr wouldn't a better way be to just avoid the Betterment portfolio allocation in my Vanguard tax advantaged 401k?  I know it's not ideal, but it doesn't seem too difficult.

[dandarc]

TLH pointers:

1.  Your losses will off-set any capital gains you have first - so you're saving 0%/15%/20%/23%+/Marginal Rate + any state taxes depending on the types of any gains you might have and your income in the year you have them.

2.  Once that is done, if you still have losses, you can off-set up to $3K of other income.

3.  After that, it carries forward to future years to offset capital gains and up to $3K per year of other regular income.

So, you're paying 45% marginal per your post.  If you have no capital gains to offset, then this year, you're off-setting $3K of income which saves you 45% of that in taxes - $1350.  You paid $2100 this year to save $1350 in taxes this year.  Yes, you've got a bank of losses to use in future years, but if you keep your money at betterment, you've also got that .15% racking up every year as well.

But even that's not the full story - you could tax-loss harvest on your own without paying betterment's fees.  You might not capture quite so much in losses, but until you realize substantial capital gains, you're only able to save taxes on the losses in a trickle anyway.

How long are you earning $400K / year?  At that income your capital gains will be taxed pretty heavily, whether long-term or short term, so offsetting those has quite a bit of value but if you back-off on the income in the future, your tax-rate on long-term capital gains could be as low as 0% + state taxes.  You might never see the full benefit of the losses you've harvested.

[TheDudeMan]

How long are you earning $400K / year?  At that income your capital gains will be taxed pretty heavily, whether long-term or short term, so offsetting those has quite a bit of value but if you back-off on the income in the future, your tax-rate on long-term capital gains could be as low as 0% + state taxes.  You might never see the full benefit of the losses you've harvested.

My hope would be that the $400 would increase throughout the years and then ideally get down to close to $0 at retirement.  In that scenario, it doesn't seem like to TLH matters much at all with a buy and hold strategy.

[neil]

Raw numbers run into some issue here.  Betterment charging $1500 on $1M isn't really recoverable through tax savings if you can only TLH $3K at a time.  Yes, you can rollover those losses, but presumably if Betterment is giving you some TLH every year you will simply be adding it up.  If you have other investments (like a lot of AAPL from 15 years ago) you can use TLH from to get you divested from it without incurring tax bills, and that might have value.  Meanwhile, you are still throwing off 2%-ish in taxable dividends and paying tax on that, and you still have a tax bill to pay eventually, so you are not saving the money forever.

If you are retiring soon, a retirement portfolio isn't likely to benefit much.  You'll get to the lowest cost basis you'll see in your lifetime at some point and then those investments will be locked in at that price.  At this point you are likely taking the dividends for expenses.  The biggest value is the fact that you are putting money in at regular intervals and the high points are being harvested and placed at a lower basis regularly.

The downside for me is if you want to change from Betterment (like how you are changing from your FP now) you are going to have a messy portfolio to figure out.  In that sense, I would not go to Betterment for the TLH, but perhaps I go because I really don't like this whole investing thing at all and want them to do it for me.  In this case the .15% fee is paying them to figure it out and the TLH business is a side benefit.  I wouldn't need TLH in retirement and would not want to continue to feed Betterment .15% (since that would just be eating at my SWR directly).

In general, I prefer knowing my portfolio since that gives me confidence to handle the swings anyway.  So my opinions are slightly biased in that direction.

[TheDudeMan]

I should've mentioned that I am 36 and don't plan to retire for a good 25-30 years.  It seems as if it doesn't make too much sense in the long run to go with a Betterment because the TLH won't offset the amount of money in management fees after compound interest works it's magic.

Has anybody come across a plug and play calculator and/or case study to determine how effective TLH really is for certain situations?

[dandarc]

If your going to keep working that long, you're going to have tens of millions someday.

You may want to check out white cost investor - his site is geared towards doctors and takes more of a look at the"I make a lot now, and intended to keep making a lot for a long time" approach